Worries About Global Slowdown, Delta Variant Still Dominates Even As Stocks Rise

Key points to remember:

  • Yields rebound, so do stocks as market executes a turnaround from Thursday
  • Concerns about the Delta variant, the future trajectory of central banks could still weigh
  • Next Week Matters With Major Bank Profits, Inflation And Retail Sales Data

Like a seesaw game, the fall in the bond market seemed to give stocks a boost on Friday morning. Yesterday it was stocks at the bottom and bonds at the top.

For now, anyway, stocks are climbing along with Treasury yields, which rise as bonds fall. The 10-year yield rebounded from yesterday’s five-month lows and recently traded again above 1.3%, which may alleviate some of the concerns about the economic slowdown that have dominated trade from Thursday.

It’s important not to get too carried away by this early rally, as things could still easily turn back in a market where caution seems to be pulling many investors into fixed income rather than equities. Today we’ll be watching rates and see if that can help the financial sector, which could also help the S&P 500 Index (SPX) and Russell 2000 Index (RUT). Along with the yields, crude is also making an appearance this morning.

Deep down, concerns about the Delta variant of Covid and a possible slowdown in the reopening likely largely explain what has happened in the past two days. People fear that international economies like Japan will not reopen as quickly as expected, suggesting that foreign central banks will not be very quick to cut stimulus programs. The news that some countries like Australia are tightening Covid protocols could scare the market if it continues.

The Fed does not operate in a vacuum and the United States is not immune to the Delta variant, although so far vaccinations have overtaken many other countries. If the European Central Bank or the Bank of Japan are to delay tapering, it could influence how quickly the Fed handles it. There was a lot of talk on Wall Street Thursday that the Jackson Hole conference August 26-28 would not take place when the Fed begins to set a schedule for cuts, and that in September or beyond, it seems more likely. We will have to wait and see.

Another thing that might be on people’s minds is a slight slowdown in recent Chinese economic data. China’s inflation data released earlier today showed a slight pullback from the previous month for producer prices. It was still high, but the slight dip raised more concerns about growth there. Consumer prices in China are only up 1.1% from a year ago, suggesting that domestic consumer sentiment remains sluggish, the Wall Street Journal reported.

Tech support holds up to SPX – so far

On the bright side, an early drop in the S&P 500 Index (SPX) below 4300 on Thursday did not last, with the SPX quickly coming back above 4300, a key psychological support point. If things start to slide further from here, a possible support level below the market is at the 50 day moving average for the SPX. That level is now around 4217. At this point in 2021, the 50 days has been tested several times and the market has rebounded steadily.

While 4300 held, it would also be technically favorable if the SPX could hold an area around 4340 today. It’s nearing the July 6 close and could be one to watch out for. It would be a good sign for the Bulls if the SPX could end the week with 4340 in the rearview mirror, so to speak.

As it stands, even with Thursday’s drop, the SPX is only about 1% below the all-time highs posted on Wednesday. It’s natural to see some selling pressure at this point, given the length of the rally.

The big banks paid the price for Thursday’s sales. Part of the pain came from shares of Bank of America (BAC) and JP Morgan Chase (JPM), both of which fell 2% yesterday. Even with today’s rebound, rates have returned to their February level and the yield curve (or the spread between long and short rates) has narrowed sharply. This tends to put pressure on bank margins. It will be interesting to hear from their leaders on the situation when the biggest US banks publish their results next week.

We’ll also have some key inflation data next week (see more below), so that might be on people’s minds. Inflation recently hit levels not seen in decades, but that was largely due to comparisons to last year’s lockdown period. Some analysts believe that inflation could remain high in the short term but slow down in the months to come.

When the bond market speaks …

In the meantime, you can’t ignore what the bond market is telling us. In some ways, this nearly 50 basis point drop in yields from March highs is a little more worrying than the rally that took us to those highs. Concerns about inflation and overheating growth have contributed to this upward trend, but these are two functions of a strong economy. Cyclical sectors like energy, financials and small-cap stocks have benefited from rising inflation fears.

If the bond market is right this time around, there is arguably a lot more to fear. Unemployment remains high from historic levels and government stimulus has started to fade. There is little that the Fed, as we’ve been told before to stimulate growth, but it’s hard to imagine another big push for stimulus controls. However, any progress in the bipartisan infrastructure package could get a positive reading from Wall Street.

Today, that doesn’t promise much in terms of economic data or earnings news. All of this is happening next week. So let’s see if stocks can strengthen ahead of the weekend or if the pressure continues. It might also be worth checking futures prices on Sunday night for clues as to what investors are forecasting for the future.

One thing to potentially watch out for today (and next week) is comments from Fed officials. It’s a bit of a quiet time, so any news from the Fed could spark a strong reaction. It really is a guessing game about what the Fed will do next and how to anticipate it.

The equality of chances: Yesterday there weren’t many stock market ports in the storm as just about every industry and type of stock was hit. Days like this suggest that people were looking beyond stocks for places to put their money, and you could see the impact of that on the rally in fixed income and the strength of the dollar index ( which peaked at three months in early withdrawal). Earlier this week, gold also rose. It’s unclear what causes so much caution, although more reports on the Delta variant probably didn’t help.

News that the Olympics in Japan would be closed to spectators put the brakes on things, essentially pointing out that while the United States appears to have made good progress in getting back to normal, not everyone has. The important thing, especially if you are a long-term investor, is not to let fear guide your decisions. If you’ve followed your plan and determine that selling certain stocks is adjusting to them at this point, then that’s okay. But selling because you see other people selling or because you are worried about a possible resurgence of the virus is about letting your emotions prevail. Trading on emotions is not a good thing to do.

A VIX check: Volatility rebounded from recent lows this week and the Cboe Volatility Index (VIX) climbed back above 18 on Thursday after briefly touching 20. The historical average is closer to 20, so things aren’t. really far from normal. As a general rule, VIX seems to have found some comfort level between 15 and 20. Also, over the past year and a half, drops to 15 seem to lead some traders to think this might be a bit of a stretch. Typically, it then bounced back between 17.5 and 20.

It would likely take a move solidly above 20 at this point to get people worried about the possible impact on the stock market. Profit season also tends to be a more fluid time, with the market more focused on the daily flow of business information and less likely to be shattered by waves of geopolitics or other outside influences. So unless we see 20 or more, you could argue that VIX is telling investors not to expect too much turbulence to come.

Key data on upcoming inflation: Next Tuesday and Wednesday mean more than the arrival of the second quarter earnings season. They also present key consumer and producer price data for June, giving investors the latest information on inflation. The core consumer price index (CPI) and the core producer price index (PPI) both rose 0.7% month over month in May. The core CPI (which excludes food and energy) rose 3.8% year-on-year in May, the highest since June 1992. The question that arises in next week’s inflation data is whether the figures for May could have represented the crescendo in prices for the year. Recent bond market action indicates that some investors may think this is the case. The benchmark 10-year Treasury yield has fallen more than 20 basis points since the release of inflation data in May, which could indicate that the bond market was in “buy the rumor, sell the fact” mode. with regard to inflationary fears.

TD Ameritrade® commentary for educational purposes only. SIPC member.

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